White Knight Fees Deductible

Santa Fe Pacific Gold Co.,132 T.C. No. 12 (2009)

The Tax Court has ruled that a corporation can deduct a $65 million termination fee it paid to a white knight to end its obligation to be acquired by the white knight and to permit it to accept a hostile offer that produced more value for its shareholders. The transaction predated the 2003 Reg. 1.263(a)-5, which would require capitalization of such a fee where the two transactions are “mutually exclusive.”

The ground of the Tax Court decision is that the actual acquirer was “hostile.” In the context of the case, this meant that the target’s management did not want the target to be acquired by that company because it was larger and they knew that it would fire them and run the target’s business the way it wanted.

Actually, as it turned out, two executives of target were retained, as were five members of the board. In fact, the concept of “hostility” really amounted to no more than the normal situation where an acquirer values a target more than the market because the acquirer can run it more “efficiently.” Since that is the essential feature of the Santa Fe takeover, the Tax Court opinion stands for the proposition that all but the most “friendly” takeovers should be expected to result in deduction of the target’s expenses, except for the matter of the current regulations.

The “hostility” finding allowed the Tax Court to find that the actual acquisition produced no significant long-term benefits for the target, which must exist before you even have to consider capitalizing related expenses. Because relatively few taxpayers will have a similar issue prior to 2004, the significance of this decision is that it might suggest how the Tax Court will view the regulations. The regulations assume that being acquired produces future benefit, almost as a matter of course. That assumption seems quite inconsistent with the Tax Court’s view in Santa Fe.


Target’s pondering deduction of expense related to a takeover should look for ways to escape the new regulation’s assumption that expenses facilitate a capital restructuring and, thus, should be capitalized. If the stakes are high enough (and the $65 million deduction at stake in Santa Fe would have been high enough), the taxpayer should consider challenging the regulations, which are “interpretive” and thus subject to relatively easy rejection by the Tax Court.